The price is right!

For a long time in business, the pricing decision was the last cog in the wheel. The consumer needs were identified, product attributes were defined, the technology to be deployed was given consideration, production centre established, then while starting the marketing process, pricing came in as a final step.

For the most part, pricing was cost-based and hence fraught with the basic chicken-egg problem. The cost depends on the volume of the production, the volume depends on the price charged from the consumers, and yet price was being decided on the basis of cost. The logic feels a little bizarre, but in many cases such a strategy would seem to work fine. It took some years before it dawned on people that pricing could be used as a strategic vehicle – to segment, to position, to differentiate, to effectively enter the market etc. and also that pricing could have a significant effect on market share. In fact in a recent report by McKinsey, it has been stated that a one-percentage-point improvement in the average price of goods and services leads to an 8.7 percent increase in operating profits for the typical Global 1200 company (the world’s largest 1200 companies by market capitalization).

Many brands have committed pricing blunders and went down under. A good example is the direction that Indian telecom operators have taken; their continuous price wars have left the industry in danger of becoming unsustainable. Similar is the case with airlines, their price slashes have caused the airline industry to bleed badly. On the other hand, several brands have exploited innovative pricing to their advantage. In the mid 90s, Ford reduced the price of their high-end cars a little bit, to stimulate purchase but not enough to cut into their margin. This price cut led to greater sale of the high-end cars, but also led to cannibalisation of their low-end cars. But since it was in the high-end cars that they had more profit margins than the low-end cars, in spite of the market share that they lost, their profits soared. Having learnt by several such examples, many companies are now investing in pricing infrastructure, right from establishing separate pricing departments to developing and acquiring pricing systems to collect accurate current pricing data and tools to transform that data into information.

There are different kinds of pricing strategies that a firm can deploy:

Differential Pricing Strategy: This strategy is deployed in order to sell the same product at different prices to consumers. Some examples of this strategy are Second market discounting, where the products are sold cheaper at a second geography assuming that arbitrage is not possible due to transaction costs by consumers; Periodic discounting where the prices vary at different periods of time depending on utility and need of consumers (Happy Hours concept in bars); Random discounting where some search or effort by consumers will result in discovering discounts (in several foreign tourist cities, discount coupons are freely available for tourists, but need to be enquired about).

Competitive Pricing Strategy: If there is a threat of competition, the periodic discounting gives way to penetration pricing and experience curve pricing, where scale and experience economies are exploited, respectively; in these pricing mechanisms the products are priced less as compared to the competitor since the producer can take low prices better due to volume or experience.

Product line Pricing Strategy: When an organization has some related products it can try different pricing strategies like price bundling/two-part pricing where products are bundled to extract maximum value from buyer (McDonald’s Happy Meal; Entry into amusement parks and separate payment for some rides); premium pricing where one brand/product of a firm may be positioned as better in quality and hence more costly than another brand/product (Hotel rooms: Suites, Luxury, Deluxe).

These were limited examples, but several more pricing strategies exist and the appropriate ones can be chosen depending on the kind of product, brand life cycle and objective of the organization. It is time to recognise that pricing plays a critical role in driving performance of an organization. Hence, organizations need to invest in appropriate pricing infrastructure and utilize pricing as a strategic tool to achieve their objectives.

References: Beyond the many faces of price: An integration of pricing strategies – Gerard J. Tellis

Building a better pricing infrastructure – McKinsey Quarterly